When Can You Start Depreciating an Asset?

Many business owners and accountants often ask if they need to fully pay for an asset before they can begin depreciating it. The answer, much to the relief of many, is no. You can start depreciating an asset immediately upon placing it in service, irrespective of the payment status. This article will explore the rules and reasons behind this practice and offer some practical insights.

The Fundamentals of Depreciation

Depreciation is an accounting method used to allocate the cost of a tangible asset over its useful life. This process enables businesses to spread out the cost of the asset over the period it is utilized, which provides a more accurate reflection of the expense in the financial statements. This practice is particularly crucial for tax purposes and for providing a more accurate representation of a company's financial health.

Depreciation Without Full Payment

You do not need to wait until you have fully paid for an asset before you start depreciating it. In fact, you can begin the depreciation process as soon as the asset is put into service, even if it is partially paid for or financed. This practice is rooted in the matching principle of accounting, which requires that expenses be matched with the revenues they help to generate.

For instance, imagine purchasing a teapot-making machine. While the initial cost could be significantly high, financing this machine through a bank does not negate the opportunity to start depreciating it. Once the machine is installed and operational, you can record the depreciation expense. The cost basis of the asset includes more than just the purchase price, as it may also encompass additional expenses like installation and delivery fees.

Accounting for Financed Assets

When you finance an asset, your accounting entries will reflect both the asset and the corresponding liability. For example, if you acquire a teapot-making machine through financing, your journal entry would credit your asset account with the machine's value (debit) and debit a liability account for the amount owed to the bank (credit).

Once the machine is operational and generating revenue, you can start depreciating its cost. This principle applies to any business asset that contributes to the generation of revenue, regardless of its funding source.

Practical Considerations

While you can start depreciating an asset as soon as it is put into service, it is essential to keep track of the asset's cost basis. This includes the purchase price and any additional costs incurred to make the asset ready for use. Managing these costs effectively can provide a clearer picture of your financial activities and help with better tax planning.

Another practical point is to ensure that the method of depreciation you choose (such as straight-line, accelerating, or declining balance) aligns with your business needs and tax obligations. Different methods can significantly impact the timing and amount of depreciation expense recorded.

Conclusion

Depreciation is a critical component of any business's accounting process, and understanding when to start this process is crucial. You do not need to fully pay for an asset before beginning the depreciation process – you can start once the asset is in service. This practice is justified by the matching principle, which aims to link expenses with the revenue they generate.

By following these guidelines, business owners and accountants can ensure that their financial statements are more accurate, reflective of true business operations, and compliant with accounting standards and tax regulations.